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Asset pricing model

A

Aisha

Member
Hello
On page 7 of chapter 8, it is said that every investor should choose a portfolio of the form :
a% of the risk free asset + (100-a)% of the portfolio of risky assets.

It is said that a can be +ve, 0 and -ve
When a is -ve, the investor borrows the risk free asset and invests in the portfolio of risky assets.

What does it mean in the real world?
 
Aisha said:
Hello
On page 7 of chapter 8, it is said that every investor should choose a portfolio of the form :
a% of the risk free asset + (100-a)% of the portfolio of risky assets.

It is said that a can be +ve, 0 and -ve
When a is -ve, the investor borrows the risk free asset and invests in the portfolio of risky assets.

What does it mean in the real world?
Click to expand...
A negative holding in the risk free asset means that an investor short sells it and combines the proceeds with the investor’s funds to buy (100 + a)% of the risky asset.
 
Hi Aisha,

If it helps you can think of a negative holding in the risk-free asset as borrowing cash e.g. from a bank. In doing so you increase the amount of money you have to invest in the risky asset i.e. you can invest more than 100% of the money you originally had.

You will of course need to pay that money back at some point in the future but you hope that the returns you make on the risky asset will be more than enough to repay the loan.

Joe
 
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